Michigan Law Would Let State Dissolve Cash-Strapped School Districts

CHICAGO - Recent defaults by two Michigan school districts on debt service payments highlight the fiscal stress facing a near-record number of districts across the state, according to credit analysts and state education officials.

Lawmakers this week will consider legislation that would boost the state’s power to intervene in and dissolve districts with major fiscal problems.

The Pontiac City School District and the Buena Vista School District both defaulted on May debt service payments. Buena Vista missed the payment after running out of cash entirely, firing all of its teachers and sending students home for two weeks until the state released previously withheld aid.

The Pontiac district, located in the city of Pontiac, which is already under state control, missed its payment in part because the state would not allow it to float the tax-anticipation note issue that it has relied on for years. Moody’s Investors Service said the Pontiac default marked the first Moody’s-rated public school district default in the U.S.

The dramatic closure of Buena Vista, with about 400 students near Saginaw, shone a light on the issue of struggling school districts across Michigan. Students eventually returned to school after the district submitted a revised deficit elimination plan that was accepted by State education superintendent Mike Flanagan.

Flanagan recently told lawmakers that the problem was at near-record highs, and the state needed more oversight to handle struggling districts.

Lawmakers in both the Senate and the House are considering a pair of House bills that would broaden the state’s authority by allowing it to dissolve cash-strapped school districts and force a merger with another district. Gov. Rick Snyder and education officials hope to get the legislation passed before the Legislature’s summer break in two weeks.

It’s been more than 30 years, since the 1980s, that Michigan has seen so many school districts with general fund deficits, said one longtime education official.

The problem is tied to declines in state aid, falling enrollment, caps on cash-flow borrowing, and the districts’ unwillingness to make deep cuts.

“The biggest thing was the loss of the federal stimulus money,” said Dan Hanrahan, director of state aid and school finance for the Michigan Department of Education. “That bailed us out for a couple of years. Then not only did we lose the stimulus money, but we had some fairly significant [state] cuts.”

Michigan had 49 school districts with general fund deficits at the end of June 2012. Hanrahan said he expects to see a few more at the end of June 2013, but that some others have recovered.

In the 1980s, the number of districts with deficits climbed as high as 80, while in the 1990s, it was less than 10, Hanrahan said.

The state has 549 regular school districts, another 260 charter districts, and 56 county-based districts.

Three school districts are operating under a state-appointed emergency manager: Detroit Public Schools since 2009, Muskegon Heights School District since 2012, and Highland Park School District since in January 2012.

Pontiac City Public Schools is under review for a state takeover. Treasury officials last week announced a finding of “probable financial stress” in the district’s finances after a preliminary review. Snyder will appoint a full financial review team to delve deeper into its books.

Moody’s Investors Service has put out a series of reports warning of the fiscal stress facing the state’s school districts. Its most recent report, released last week, warned of “sharp financial and liquidity strain” facing some districts.

“The issues have been percolating for a number of years,” Moody’s analyst Matthew Butler said in an interview.

“The biggest issue facing Michigan school districts is the combination of flat to reduced state funding as well as, in certain districts, very rapid and significant declines in enrollment,” he said. “That translates directly into loss of revenue.”

The state’s declining population coupled with increased competition from charter schools and neighboring districts, where students can transfer if there’s an opening, has aggravated the problem, Butler said.

Lawmakers are still hammering out a final 2014 budget, but the massive K-12 school aid spending plan is largely finished. It features modest increases of 1% or less, in per-pupil spending. Butler said the increase is not enough to offset the most recent reduction, in 2012.

“Given the fact that enrollment statewide is down, the modest growth in state aid is not quite making up for what’s happened in prior years,” he said. “We definitely see some pressure in the sector going forward.”

The 2013 budget increase will allot an additional $30 to $60 in per-pupil state aid depending on a district’s current aid. Per-pupil state aid averages $6,999, according to Hanrahan. The biggest cut came in 2011, when the state reduced aid by $476 per pupil.

The school districts did not always respond to the cuts with their own cutbacks, Hanrahan said.

“It’s not all a resource issue,” he said. “Some of our districts didn’t react fast enough to the reduction in resources -- they were historically giving increases in salaries and not reducing benefits.”

The Pontiac district, rated Caa1 by Moody’s and on review for downgrade, disclosed on May 24 that it had missed its May 1 $1.4 million payment on general obligation limited-tax bonds issued in 2006. The bonds are insured by Syncora, which was unaware of the missed payment until the paying agent notified it on May 21, according to Moody’s.

The insurer paid the bondholders, but as of Monday, the district had not yet repaid Syncora.

The district has relied on short-term borrowing for years to cover cash-flow shortfalls, but the state has not yet allowed it to issue the notes this year, according to Moody’s. The state also withheld its March and April state aid payments because the district did not comply with its deficit elimination plan. The moves likely contributed to the default, Moody’s said.

The state also withheld Buena Vista state aid payments, likely one of several factors that contributed to its shutdown in May. Other factors include an increase in tax appeals, accumulation of late payments, and the use of debt service funds for operating purposes, according to Moody’s. The district disclosed May 31 that it had missed a May 1 debt payment.

In a recent comment on the defaults, Butler said other districts with deficits face cash flow problems, but probably won’t reach the crisis levels of Buena Vista or Pontiac unless their state aid is disrupted.

House Bill 4813 and 4815 are aimed at increasing state power to intervene. A hearing is scheduled for Tuesday afternoon.

The legislation would allow the state education superintendent and state treasurer to dissolve any school district that fails to submit a deficit plan or is not financially viable. Any bonds issued for the district would remain with the local taxpayers until paid off, and the students would head to a neighboring district.

Sen. Phil Pavlov, R-St. Clair, chair of the Senate Education Committee, told local reporters that he is open to considering the bills in the next two weeks but that “there are a lot of questions.”

“This is a major policy direction that [the Snyder administration] is asking us to go down,” Pavlov said on a MIRS News podcast. “I’m not convinced we need as many school districts as we have,” he added, saying local school boards need to be “held accountable” when they are not providing accurate or timely information to the state. “But local control of public education is a very important concept.”

With the number of districts with deficit higher than anytime in the last three decades, Hanrahan said he is starting to think that enhanced state power is a necessary tool.

“You feel bad about it because we’re a local-control state, and we’ve always let school districts and other local governments control themselves and not be run heavy handedly by the state,” he said. “But what we’re seeing in some of these instances is the local boards just can’t get themselves to do it. There’s the concept of community schools, and it’s hard to lose that, but I’m coming around to the point of thinking it probably is necessary.”

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